Henry Salvatori Professor of Law & Community Service at Chapman University School of Law, specializing in constitutional law

Wednesday, January 11th, 2012

California is broke. Every year we spend about $20 billion more than we take in, despite a constitutional requirement of balanced budgets. Our elected officials have tried every trick in the books to make it appear that they have not been acting unconstitutionally. They’ve “borrowed” from local governments and schools with phony promises to repay next year, much as Wimpy used to promise Popeye that he’d pay on Tuesday for a hamburger today. Total outstanding tab on these gimmicks – about $40 billion and counting. They’ve bond-funded current operating expenses as well as everything else they can think of, from school buildings to stem cell research. Current tab – more than $77 billion, the second-highest per capita general obligation debt load in the country.

But by far the largest part of our bankruptcy-inducing debt is unfunded pension and health care benefits promised to public employees, extracted over the years from public employee union bosses who practically own the legislature in Sacramento. Even in the best scenario of investment returns that match the average rate over the past century, the unfunded liability is a quarter of a trillion dollars. And if you recognize that we may be in for a long haul of lower-than-average investment returns because of the dysfunctional state of our governmental finances, the total could be more than double that, bringing the State’s total indebtedness to about $747 billion. That’s three quarters of a trillion. $747,000,000,000,000. Or about $19,800 for every man, woman and child in the state. (Increase by about a third if you exclude children, and then double the remainder if you exclude those receiving government benefits rather than supporting the government with their taxes, and you probably have a debt in excess of $50,000 for every working adult in the State).

Draconian cuts in governmental services are coming if we cannot figure out a way to trim the costs. Yet despite the looming financial calamity and the recent recession, public sector pay and benefits have continued to increase at a rate well above inflation, and the public sector pension systems have become the envy of the world, affording a lifetime of lucrative income streams in retirement that rival and in many cases exceed the paychecks received when the employee was actually working. Nothing in the private sector comes close to comparing.

Everyone recognizes this has to change. But there is a view in Sacramento that change can only come to the contracts of future government employees. The Contracts Clause of the U.S. Constitution, we are told, prevents us from modifying existing contracts, or even reducing the contractual pay, benefits and pensions of current employees when their current contracts expire. States are not allowed “to impair the obligations of contracts.” If that view of the Constitution were correct, those who raided the state’s treasury would have a perpetual claim to keep raiding it, with taxpayers (through higher tax rates) and future government employees (through lower salaries and benefits) obliged to keep the money flowing.

Could our nation’s Founders possibly have been so foolish? The simple answer is: “Of course not.” This absolutist view of the Contracts Clause makes little sense and, not surprisingly, is not supported by judicial precedent.

Contracts entered into through fraud and duress, for example, are not binding. Think City of Bell! Neither are contracts that are made in excess of the government official’s authority, such as the slew of retroactive increases to pension benefits that the legislature authorized a decade ago in violation of the state constitution.

More significantly, the Supreme Court has subsequently recognized other limits on the Contracts Clause. The state can never contract away is basic sovereign powers, nor impose on the legislative judgment of future legislatures. To use the Court’s language in Stone v. Mississippi, “no legislature can curtail the power of its successors to make such laws as they may deem proper in matters of police.” Because the existing pension systems in many states and localities are severely underfunded, a credible argument can be made that the legislatures which authorized but did not pay for the existing pensions are intruding upon the police powers of future legislatures, who will find themselves severely curtailed in their exercise of their police powers because of unfunded liabilities they inherited from a spendthrift prior legislative body.

More recently, the Supreme Court has recognized that the Contracts Clause cannot be read as an absolute prohibition on the impairment of all contracts because a state “continues to possess authority to safeguard the vital interests of its people.” In other words, States may impair the obligations of their own contracts, even substantially, if “reasonable and necessary to serve an important governmental purpose.”

That idea has recently been applied by several federal courts of appeals addressing Contracts Clause challenges to reductions in government employee pay and benefits mandated by government in order to meet a fiscal crisis. In two of the three most significant cases, one out of Baltimore and the other out of Puerto Rico, the U.S. Courts of Appeal for the Fourth and First Circuits, respectively, held that reductions in current government employee salaries, in response to a financial crisis, did not violate the Contracts Clause. And in a 1993 case out of Nevada, the Ninth Circuit accepted the general proposition, invalidating a Nevada effort to fund an increase in retiree benefits by eliminating an existing contractual right of current employees, only after finding that the substantial contract impairment for current employees was not “necessary” to the funding proposal.

Of course, states cannot simply breach existing contracts for frivolous reasons. States cannot consider renouncing existing contracts on a par with other policy choices, for example, or impose a drastic impairment when a modest one would suffice. But the fact that taxes could always be raised, or government services slashed, does not mean that impairment of existing contracts is never necessary. Given the dire financial straits in which California finds itself, and the limited alternative options available to it (increased taxes having been rejected by the voters, and the budget-cutting axe already cutting into essential governmental services), the situation now prevails in which even substantial impairments of existing contractual obligations can be made without running afoul of the Contracts Clause, because such a course is “reasonable and necessary to serve an important governmental purpose,” namely, the continued provision of essential governmental services across the State.

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